Chipotle Looks Beyond Busy Urban Cities As It Expands Across America

As Chipotle Mexican Grill (NYSE:CMG) expands to more places, the restaurant chain is increasingly looking beyond metropolitan cities to open its next set of restaurants. Keeping this in mind, the company decided to open A Model restaurants from 2010 onward. Close to 25% of the new additions in the same year were A Model type restaurants. In 2011, the figure jumped to 30% and it is expected to remain the same in 2012. [1]

A Model restaurants are opened in secondary trade areas where the average cost of opening a new restaurant as well as the occupancy costs are lower. At the same time, you can expect average revenue for an A Model store to be lower than that for a traditional restaurant. Overall, the company feels the demographics of the area are good enough to open the restaurant such that profit and return on investment are maintained.

In 2010, the average cost of opening a restaurant declined to $795,000 from $850,000 in the previous year. Since one-fourth of these new additions were A Model type of restaurants, the average cost of opening such a restaurant was $630,000. That price might have jumped due to a partial recovery in the housing and rental market. Still, for 2012, the figure shouldn’t exceed $650,000 which is 25% lower than opening a traditional Chipotle restaurant. [2]

Success of this type of restaurant is also critical in the long run since all of the restaurants are company-operated (i.e. none of them is franchised). Thus, the entire cost of opening a new restaurant falls on the company. And since neither international expansion nor the accelerated openings of its Asian cuisine venture, ShopHouse Kitchen, can be ruled out in the future, optimizing capital expenditure will be a key aspect in generating the required cash flows.

Smaller Restaurants

The trend seems to be that the new restaurants are smaller in size. The average restaurant size seems to have declined from 2,590 square feet in 2010 to 2,565 in 2011. Therefore, the average size of the new additions in 2011 was 2,380 square feet, or about 8% smaller than the size of the existing restaurants. [3]

Chipotle doesn’t reveal too much information about the A Model restaurants specifically but based on the information given out on average revenue per store and comparable sales, we estimate average revenue generated for an A Model restaurant should be about 15% lower than that for a traditional restaurant.

Also, as mentioned earlier, the new additions are generally smaller in size so the lower revenue per store is not unexpected. Moreover, customer traffic and purchasing power are generally lower in secondary trade areas which again contributes to lower revenue per store. But, given its relatively lower capital requirements and occupancy costs, A Model restaurant still seems to be an attractive proposition. The company has entered a stage where it can leverage its brand name as well as supply chain to open a large number of smaller restaurants at places where it feels the dynamics of profitability are right.

However, pricing could be an impediment in the expansion process. Chipotle generally has higher menu prices compared to other fast food chains. The restaurant chain is already feeling the heat from Taco Bell, which has rolled out a similar menu at much lower prices. And you would generally expect the customers in secondary trade areas to be more price sensitive than their big city counterparts.

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